Loeb Belief in Abenomics Drives Pursuit of a Sony Shakeup

By Beth Jinks and Jason Clenfield -
Jun 18, 2013

Activist Daniel Loeb took his team
to Japan in April 2012 to determine if the world’s third-largest
economy was ready for investment. The central bank had set a new
1 percent inflation goal, an encouraging step in a country where
growth had stagnated for two decades.

Yet Loeb wasn’t convinced until October when polls signaled
that the next prime minister would be Shinzo Abe, a pro-business
leader who agitated for reforms including a weaker currency and
unprecedented monetary easing to end deflation.

As the economy blossomed in the first five months of 2013,
the stock market soared and the yen fell, Loeb decided the time
was right to push for a shakeup at Sony Corp. (6758) It reflected his
confidence that Abenomics had primed hidebound Japan for a
polite version of American-style activism even at an iconic
company.

A new Sony board will test that confidence after the
company’s annual shareholder meeting in Tokyo tomorrow. Three
new directors and a chairman will replace four outgoing members,
including Welsh-born Chairman Howard Stringer, 71. They will
reconstitute the group that will tackle activist proposals by
Loeb’s Third Point LLC including an initial public offering of
as much as 20 percent of Sony’s entertainment assets.

“Sony has an opportunity to serve as a shining example of
how structural reforms, the ‘Third Arrow’ of Prime Minister
Abe’s economic plan, can be implemented successfully through
constructive shareholder engagement,” Loeb wrote to Sony Chief
Executive Officer Kazuo Hirai on June 17.

Underlying Value

New York-based Third Point, which manages $13 billion,
disclosed that it had increased its stake to about 6.9 percent
of Sony shares, which it valued at $1.4 billion, from the 6.3
percent announced on May 14. Its stock has climbed 8.5 percent
since the plan first became public.

Loeb is urging the partial carve-out of Sony’s music and
film unit to unlock its underlying value and provide capital for
management to focus on turning around the consumer electronics
business. By creating an independent entertainment board,
managers would be more accountable and would help in setting
growth targets and allocating capital, Loeb wrote.

Sony’s market value has fallen to about $21 billion from
more than $120 billion in 2000. While a weaker yen, job cuts and
blockbuster movies like “Skyfall” have helped Hirai return
Sony to a profit after four years of losses, the company’s
smartphones and flat-panel televisions are still being battered
by competition from Samsung Electronics Co. and Apple Inc.

Consecutive Losses

Sony’s main TV business has lost a total of 762 billion yen
($7.98 billion) from selling TVs in nine consecutive years of
losses. Without the contribution of the profitable entertainment
units and its insurance arm, Sony would have booked a 130
billion yen loss in the year ended March 31.

While Loeb’s plan, coming after a deadline for shareholder
proposals, isn’t on the meeting agenda, Hirai has said directors
will study it closely. He has hired banks for advice, Morgan
Stanley and Citigroup Inc., a show of receptiveness that
contrasts with the routine rebuffs previous activist efforts
have elicited from Japanese corporate targets.

Loeb will have to overcome the skepticism of some close to
Sony that his proposals are the right way to unlock
entertainment’s value and tackle the ailing electronics
business, people familiar with the matter said. Sony had almost
$8.6 billion in cash and undrawn credit as of March 31,
and has issued four bonds since the start of 2012, suggesting
selling part of a profitable unit to raise capital isn’t
necessary.

He also needs to overcome Japan’s traditional resistance to
foreign influence.

Insular Culture

“Japanese corporations have long been insular to this kind
of restructuring and outside interference,” said Michael Marks,
the former CEO of contract manufacturer Flextronics
International Ltd. (FLEX), and a founding partner of investment firm
Riverwood Capital LP, who has done business in Japan for about
30 years. “My bet is on the no-big-changes side of the
equation.”

Loeb’s optimism is rooted in part in his conviction that
Abe will succeed in carrying out reforms to wrench Japan from
economic stagnation, said a person familiar with his thinking,
who asked not to be identified because the discussions weren’t
public. He is encouraged by the people Abe’s brought in to
govern, as well as the academics and officials he consulted
during five years in the political wilderness, the person said,
including retired Yale University professor Koichi Hamada and
Kaetsu University’s Yoichi Takahashi, a former Finance Ministry
official who advocated a surge in Japan’s monetary base.

Solidifying Control

After next month’s upper house elections, when polls show
Abe’s Liberal Democratic Party is likely to solidify control of
parliament, Loeb’s camp expects him to use the next three and a
half years to push his agenda beyond a weaker yen, said the
person. The hedge fund is looking for moves ranging from
corporate tax overhauls and aggressive deregulation, to
increasing women’s participation in the workforce as Japan’s
aging population retires.

So far, it’s in monetary policy where Japan has made the
biggest break from the past. Before Bank of Japan Governor
Haruhiko Kuroda pledged to double the BOJ’s monthly bond
purchases and do “whatever it takes” to end deflation, the
country’s central bank chiefs had stuck to policing bubbles
rather than fostering growth.

Loeb has already won his first bet by shorting the yen
starting in October, a person familiar said. The currency fell
by as much as 11 percent against the dollar as Kuroda unveiled
in April the Bank of Japan’s most aggressive quantitative easing
yet.

Higher Confidence

Abenomics has boosted Japanese sentiment. Consumer
confidence last month climbed to the highest since 2007 and
major companies plan to raise summer bonuses by the most in more
than 20 years, according to a survey by Keidanren, the country’s
biggest business lobby.

For Sony, the weaker currency will make its exports cheaper
and inflation and faster economic growth could revive a domestic
market that makes up about a third of the electronic maker’s
sales.

While investors are skittish about whether Abe can deliver
on his promises -- the Nikkei 225 Stock Average has plunged 17
percent in the last four weeks as the yen strengthened --
Japan’s market is up more than 25 percent this year, the most
among developed markets.

“We’re telling clients that the rally isn’t over,” said
Soichiro Monji, chief strategist at Tokyo-based Daiwa SB
Investments Ltd., which manages the equivalent of $59.6 billion.
“The economy and corporate earnings are improving and we have
high hopes for Abe’s administration.”

Closer Look

Loeb’s plan may get a closer look thanks to the presence of
new outsiders on Sony’s board. Former Apple executives Eikoh Harada and Tim Schaaff are expected to be named directors at the
shareholder meeting, as well as Joichi Ito, a director of the
Media Lab at Massachusetts Institute of Technology.

“They’ve been transparent with the use of outside advisers
and I think it’s actually a triumph of corporate governance,”
said Damian Thong, an analyst at Macquarie Securities Ltd. in
Tokyo.

To be sure, Loeb isn’t the first U.S. hedge fund to take a
crack at Japan Inc. In the early 1990s U.S. investor T. Boone Pickens bought 26 percent of Koito Manufacturing and tried to
obtain a board seat. The parts supplier to Toyota Motor Corp.
spent a reported $4.4 million to thwart him and he dumped the
shares.

Some activist investors are rooting for Loeb to succeed at
Sony, as it could open the door for them to go after other
Japanese companies ripe for restructuring, said another
activist, who asked not to be named.

‘Binary Outcome’

Abenomics presents investors with a “sort of a binary
outcome,” said Erik Davidson, deputy chief investment officer
for Wells Fargo Private Bank, which oversees about $170 billion.
“Japan could do really well, this could be the turning point
for that country, or this could be the end game for Japan, sort
of a last ditch effort.”

Still, Davidson, who earlier lived and worked in the
country for six years, returned from a Japan research trip in
April and liked what he saw, despite its shrinking population
and other challenges. He raised his recommendation for Japanese
investments to neutral from underweight.

“Japan may finally, finally be at a turning point in their
battle against deflation, which has rewarded procrastination for
15 years,” he said. Today “investors ignore Japan at their own
peril.”